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COST-BENEFIT ANALYSIS






A PROJECT SUBMITTED TO THE FACULTY
OF NATURAL SCIENCES IN PARTIAL FULFILLMENT
OF THE SUBJECT ECOLOGY 1A








SUBMITTED BY:

COLL, PRINCESS MARIE
GALVES, CHRISTINE
LUCAS, NATALIA SOPHIA
RAMIREZ, MARICAR
RAMOS, QUEENCY





SUBMITTED TO:

MR. RONALDO S. FELIZCO



FEBRUARY 12, 2013
1:30-2:30 TTHS


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Cost benefit analysis is the evaluation of the cost that we are willing to spend or risk and
the benefits we can get or incur in a certain project. We can apply this in decision making to see
if the cost is worth its benefits or better, if we could gain more than what we lost. Analytical
assessment of the project is necessary to weigh the benefits and costs that we could possibly
incur and to assure if the project is worth it. Determination of the cost and benefit of a project is
also necessary for the individuals concern in decision making, for them to avoid mistakes and
utilize their properties properly to gain profit and not loss.

Example of benefits:
Provision of employment for a range of skills
The value of output as a contribution to economic growth
A possible contribution to sustainable development and the more efficient use of
natural resources
A possible boost to exports and reduction of imports
Example of costs:
Capital expenditure
Costs of raising capital and interest payments
Compensation for social dislocation, acquisition of properties
Research, design and development costs

Before engaging into a contract for a project, here are the steps on how to make a cost
benefit analysis:
1. Identification of the project to be evaluated.
2. Determination of all impacts, favorable and unfavorable, present and future, on
society.
3. Determination of the value of these impacts, either directly through market value or
indirectly through price estimates.
4. Calculation of the net present value making use of the discount rate.

A profitability indicator is a single number that is calculated for the characterization of
project profitability in a concise, understandable form. The following examples are some of the
most commonly used methods in calculating profitability indicators:

A. Simple payback
Payback Period Analysis measures the amount of time a project will take to return its
original investment.
It ranks projects according to the length of the period- the shorter the period, the more
profitable and attractive is the project.
Simple Payback Period is the amount of time it will take to generate enough cash flow to
recover the initial investment.
In P2/CP (Pollution Prevention/ Cleaner Production) investments, the net cost savings
usually represent the projects cash flow.

Simple Payback = Initial Investment
( in years) Year 1 Cash Flow


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B. Benefit-Cost Ratio
It is defined as the ratio of the present value of project benefits to the present
value of costs.
Also known as the profitability index, it is used to determine the feasibility of a
project during any given year over a time span.

C. Internal Rate of Return
It is defined as the discount rate at which the present value of project benefits
equals the present value of costs, meaning, it will yield a net present value of zero
for a given stream of cash flows.
It allows a comparison between the IRR of a project and a companys self
determined market rate of return.
If the IRR (expressed in percentage terms) is greater than the market rate of return
or any other socially acceptable rate of return, the project will be accepted.
It tells exactly what discount rate makes the project just barely profitable.

D. Net Present Value (NPV)
NPV is the sum of the discounted cash flows over the lifetime of a project.
This analysis relies heavily on the concept of time value of money and is a
powerful tool for assessing profitability over the life of a project.
The time value of money measures the value of money at different points in time
as determined by a discount rate. Money now is worth more than money in the
future because of inflation and or investment opportunity.
The time value of money is considered in the financial analysis of cleaner
production projects when the cash flows received over the lifetime of the project
are converted to their present values.
Importance: The time value is important in the financial analysis of P2/CP
projects since the project has an initial investment cost that occurs now,
but the cash flows or savings from the project will only accrue to the
company over a period of time in the future.
Implication: To find out the profitability of the project, the initial
investment (amount of money to be spent) on the project should be
compared to the time-adjusted (present value) cash flows of the project
over its lifetime.

A positive present value (+) occurs when the sum of the present values of all the
cash flows from the project (investment cost and cash flows over the projects
lifetime) is greater than or equal to zero (0) or NPV is positive which means that the
project is profitable at the time frame. The clear choice is a project whose NPV > 0
or, if there are several alternatives with positive NPVs, the choice would be the
alternative with the higher NPV.
A negative present value (-) occurs when the sum of the present values of the cash
flows from the project (investment cost and cash flows over the projects lifetime) is
less than zero. It implies that the project is considered unprofitable at the time frame
and at the discount rate used in the analysis. Any proposal with a NPV < 0 should be

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dismissed because it means that a project will likely lose money or not create enough
benefit.
The present value of future benefits and costs of a project must be calculated and
compared to the present value of investment costs.


Formula:



Where: NPV = Net Present Value
B
T
=

Total Benefits
C
T
= Total Costs
r = Discount Rate
t = Time



Discount Rate
Discount rate refers to the percentage used to calculate the NPV. It reflects the time value
of money and the risk or uncertainty of the anticipated future cash flows. It is needed to calculate
the present value of investment costs. The choice of an appropriate discount rate is critical. In
project analysis, the choice of a discount rate makes a big difference because a project is likely to
show different benefit-cost ratios depending on the discount rate used. The fact that the
implementation of a project transforms present consumption into future consumption makes it
very important that the transformation is done at a percentage which is most desirable to society.
For most analysis, the discount rate is selected and determined by the existing bank rate which is
used to derive the net present value of the project.

NPV Sample Problems:

1. A coastal area is currently not in use and on which society does not place intrinsic value.
The government is considering developing the area into a marine amusement park. The
initial construction cost of the park will be 3,970,000 and there will additionally be annual
maintenance costs of 230,000 each year that the park operates after the year in which it is
built. The government also wants to consider the fact that people who use the park will not
undertake other forms of leisure that they would have undertaken in the absence of the park;
they estimate the value of this foregone recreation as 5,000 per year beginning the year
after the park is built; this represents an additional recurring annual cost. The government
expects that 1,200,000 in tourism revenue will be earned per year beginning the year after
the park is built, representing the recurring annual benefit of the project. The government
requires use of a discount rate equal to 5% and sets a 5-year time horizon. Calculate the Net
Present Value. Is the project feasible?

Solution:

n
t
t
t t
r
C B
NPV
0
1

n
t
t
t t
r
C B
NPV
0
1

5

Given: B= 1,200,000
C= 3,970,000, 230,000, 5,000
r= 5%
t= 5 years

t=0 NPV = - 3,970,000
(1.05)
0

NPV = - 3,970,000

t=1 NPV= 1,200,000-(230,000+5,000)
(1.05)
1

NPV = 919,047.62

t=2 NPV= 1,200,000-(230,000+5,000)
(1.05)
2

NPV = 875,283.45



t=3 NPV = 1,200,000-(230,000+5,000)
(1.05)
3

NPV =833,603.28

t=4 NPV = 1,200,000-(230,000+5,000)
(1.05)
4

NPV

= 793,907.89

t=5 NPV = 1,200,000-(230,000+5,000)
(1.05)
5
NPV = 756,102.75



NPV= - 3,970,000 + 919,047.62 + 875,283.45 +833,603.28 + 793,907.89 +756,102.75

NPV
5years
= 207,944.99 The project is feasible.



2. Philippine Eagle Power Company is considering a hydropower project. It would cost
100 million to build a facility that would take advantage of a serendipitous gift of nature. A
certain swift river running through a mountainous region passes through a narrow valley
adjacent to a mountain called White's Peak. On the other side of White's Peak is a much
deeper valley, but the mountain prevents the river from reaching it. An abandoned mine,
however, bores through the mountain and comes within a short distance of the river. By
running a pipeline through the mine and boring on to the river, a substantial flow of water
could be diverted into penstocks flowing to the lower valley. A hydroelectric power plant
would be built to take advantage of the steady flow of water to drive its turbines. Once built,
the plant would operate automatically and require minimal maintenance of 100,000
annually. Philippine Eagle Power expects to get electricity worth 35 million annually for 3
years. Discounting at 10%, calculate the projects NPV. Should the company pursue the
project?

Solution:

Given: B= $120 million
C= 100 million, 100000
t= 3 years
r= 10%

n
t
t
t t
r
C B
NPV
0
1

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t=0 NPV = - 100,000,000
(1.10)
0

NPV = - 100,000,000

t=1 NPV = 35,000,000 - 100,000
(1.10)
1

NPV = 31,727,272.73

t=2 NPV = 35,000,000 - 100,000
(1.10)
2

NPV
=
28, 842,975.21

t=3 NPV = 35,000,000 - 100,000
(1.10)
3

NPV = 26,220,886.55

NPV = - 100,000,000 + 31,727,272.73+28, 842,975.21+ 26,220,886.55


NPV
3year
s = - 13,208,865.51 The project should not be pursued.



3. A business is considering changing their lighting from traditional incandescent bulbs
to fluorescents. The initial investment to change the lights themselves would be
40,000. After the initial investment, it is expected to cost 2,000 to operate the
lighting system but will also yield 15,000 in savings each year; thus, there is a
yearly cash flow of 13,000 every year after the initial investment. For simplicity,
assume a discount rate of 10% and an assumption that the lighting system will be
utilized over a 5 year time period.

Solution:



t = 0 NPV = (-40,000)
(1 + .10)
0

NPV = -40,000.00
t = 1 NPV = (13,000)
(1.10)
1

NPV = 11,818.18
t = 2 NPV = (13,000)
(1.10)
2

NPV = 10,743.80



t = 3 NPV = (13,000)
(1.10)
3

NPV = 9,767.09
t = 4 NPV = (13,000)
(1.10)
4

NPV = 8,879.17
t = 5 NPV = (13,000)
(1.10)
5

NPV = 8,071.98
NPV
5years
= - 40,000.00 +11,818.18 +10,743.80 +9,767.09 +8,879.17+ 8,071.98
NPV
5years
= 9,280.22.


Many decisions about natural resources are influenced by basic economic considerations which
include the following factors:

n
t
t
t t
r
C B
NPV
0
1

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TIME PREFERENCE
It is the relative valuation placed on a good at an earlier date compared with its valuation
at a later date. It is the measure of a persons willingness to postpone some current income for
greater returns in the future.

The time preference that an individual exhibits at any given moment is determined solely
by their personal preferences. As such, if one "prefers" to save his money but cannot do
so in the present, he is still considered to have a low time-preference. One of the factors
that may determine an individual's time preference is how long that individual has lived.
An older individual may have a lower time preference (relative to what he had earlier in
life) due to a higher income and to the fact that he has had more time to acquire durable
commodities (such as a college education or a house).
The factors that influence a ones time preference are:
1. Current needs
If you dont have enough money to buy a certain thing, you would choose to have
the money now and will not wait for a long period of time for that money to
arrive.
2. Uncertainty
There is no assurance that you could have that item in the future period.
3. Rate of return
If you are sure that you could gain profit from that item, more likely youll wait
and have that income.
4. Inflation
In economics, inflation is a rise in the general level of prices of goods and
services in an economy over a period of time. This greatly affects the decision of
investors upon investing with greatly assurance that it will not be their loss in case
inflation happens.

Applying this to management of natural resources, we can have agriculture as an
example. With regards to land management, farmers can choose between
depletion strategy and conservation strategy. Depletion Strategy can be used to
acquire an immediate high rate of return for a short period. This method might
entail the use of multiple cropping, artificial fertilizers, herbicides and pesticides
to maximize production. This method might not consider soil eroin control and
other techniques. The other option is the conservation strategy wherein techniques
to conserve topsoil and maintain soil fertility are involved. These may require
immediate monetary investments. The farmers may spend more at the beginning
but this method has the greater probability to give smaller loss of future income
from soil erosion.
As a summary:
Time preference is the inclination of a consumer towards current consumption
(expenditure) over future consumption, or vice versa. What may induce a consumer to
delay consumption is called Rate of Time Preference amount of money (expressed as a
proportion of the consumer's current income) that will compensate him or her for
forgoing current consumption. This rate corresponds with the market interest rate and

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depends (among other factors) on the consumer's expectations of the future income. If the
future income is expected to be higher than the consumer's current income, he or she will
have a high rate of time preference; thus, the interest rate has to be high enough to induce
savings instead of spending. Similarly, if the future income is expected to be less than the
current income, a rational consumer will be inclined to save even if the interest rate is
low. Also, the consumer's rate of time preference (hence the interest rate demanded) is
likely to raise as the amount of his or her savings rises. Therefore, the consumer will limit
his or her savings to the amount at which the rate of time preference equals the rate of
interest.

Opportunity Cost
Opportunity Cost is the cost of lost or missed opportunities. It is the cost of an
alternative that must be forgone in order to pursue a certain action. Put another way, it is
the benefit/s you could have received by taking an alternative action. For example, if the
investment used in a conservation strategy is used to put up a new business venture, the
money and profit that will be earned from that new business venture is the opportunity
cost. This profit is usually easily earned with less work making the farmers and growers
opt for other strategies other than conservation strategy.


References:

Asafu-Adjaye, John. 2005. Environmental Economics for Non-Economists:Techniques
and Policies for Sustainable Development .World Scientific Publishing Co.Pte.Ltd., Toh
Tock Link, Singapore

Anderson, David A. 2010. Environmental Economics and Natural Resource
Management. Routledge, New York, New York

Felizco, Ronaldo S. 2012. Ecology1A. A Compilation of Notes/ Seatwork /Assignments/
Practice Test Questions with Recourse Information

http://www.investopedia.com/terms/o/opportunitycost.asp#ixzz2KZiLyfGe

http://epb.apogee.net/res/refpay.asp

http://www.greenbiz.com/sites/default/files/document/CustomO16C45F7762.pdf

http://www.investopedia.com/terms/d/discountrate.asp#ixzz2KZsMzY8Y